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Paul and Brett's Alpha

December 2023

Epoch-defining, versus defining an epoch

In general terms, we love our job. We are healthcare geeks who get to spend our time thinking about the industry, and talking with opinion leaders and c-suite executives about future developments. When not talking to companies or thinking about the outlook, we are engaging with investors, which is also generally both an enjoyable and intellectually stimulating experience.  

Clearly, it’s a lot less fun when markets seem irrational, performance is challenging and, as a consequence of these two factors, our investors are frustrated or concerned. In the this latter regard, 2023 has been the toughest year that we can recall.  

We touched on some of these points in the November missive, but one can summarise as follows: in the minds of a client, it is unarguable that a portfolio manager is not doing the job they are paid to do if the fund they manage is not outperforming its benchmark. The longer any period of under-performance has gone on for, the more reasonable and appropriate it becomes for the investor to question the strategy and approach of the fund manager.  

If performance suddenly seems to deteriorate, then those questions may take on additional urgency, since all investments have an opportunity cost of capital and portfolios are supposed to diversify and thus mitigate overall risk, volatility and factor exposure. It’s bad enough as an investor to be losing money, but it hurts even more if you see that you could be making money by placing it somewhere else.  

It is also fair that investors expect portfolio managers, who typically market themselves as experts in a given field, to have credible answers to questions regarding the drivers of underperformance and a view on when that situation might begin to reverse and performance recover.  

We recognise all of these points and fully accept any questions or criticisms that come our way. It is part of the job. The challenge in assuaging concerns or answering questions amidst such periods comes from the inherent problem of idiosyncratic market behaviour.  

There is no real answer to why stock markets do some of the things they do. Bubbles appear and then they burst. In hindsight, many a book is written that points out the lack of objective fundamental analysis during crazier times, but still history repeats itself.  

When we look back on 2023, there have been many curve balls. Each on their own stands up to objective analysis, in the sense that they fall into two camps: it makes sense to empirically adjust net present values in the face of evolving fundamentals (e.g. rising interest rates and persistent inflation or a declining earnings outlook) or it does not – i.e., one cannot really justify why the ‘event’ had such a profound impact (basically everything else that happened during the course of the year).

There are various examples of the latter that we could cite, but three critical scenarios come to mind:  

1. The collapse of Silicon Valley Bank on 7th March 2023. It was very difficult to identify any public companies with material deposits at this entity and, in any event, the Federal Reserve stepped in and guaranteed all deposits within five days of its collapse. Nonetheless, the S&P400 Healthcare and Russell 2000 Healthcare Indices fell 600bp over the following week. The Trust’s NAV fell 7.5% in dollar terms over that period, despite no SVB exposure for portfolio companies.  

2. The AI frenzy. It is difficult to pinpoint precisely when or what made everyone go crazy for machine learning and large language models, but it looked to have really gained traction around May 2023, which happened to coincide with Open AI making a smartphone app for ChatGPT available on the iPhone, which allowed easy access for the masses (including journalists and wall street pundits) to a powerful AI tool for the first time. 

NVIDIA’s Q1 23 results also looked to have played a role around the same point, with the company revealing expectations for a large sequential revenue acceleration on increased demand for its AI-optimised data centre chips. Within a month of NVIDIA reporting, the S&P500 Information Technology Index had pulled a 600bp performance gap over the S&P500 Healthcare Index.

NVIDIA’s results clearly show that IT capex is going toward building more and more AI capabilities into new data centres, and these tools are becoming more useful in the broadest sense. That said, we could spend hours citing examples of how unfit they still are for many mainstream applications and, as we discussed in last December’s missive, the world seldom changes as quickly as people like to imagine. 

3. The over-reaction to the “likely” (or not) impact of GLP-1 obesity drugs on the wider healthcare ecosystem from a utilisation perspective. We will not dignify this with further commentary, beyond observing it has been one of the most bizarre and irrational things we have seen in our many decades working in capital markets, redolent only of the late 1990s tech frenzy in terms of the insanity and inanity on display. 

History will ultimately decide how to describe 2023 from an investor standpoint, and we are all probably too close to it right now to objectively place it in its proper perspective. However, the varied (mis)fortunes of the portfolio, which has been fairly consistent in terms of holdings and exposures throughout this period, is instructive though. No one could reasonably have foreseen any of the three events described above and, as far as we know, no one did.  

They were manifested into existence by the combination of greed and fear that drives all extreme market moves. In the end, one might conclude that it all worked out “fine”. We are still smarting from the pasting we took in 2022 and think that valuations for many companies we own remain egregious. In our minds, we are still “owed” a lot of relative performance from good companies that have been unfairly punished.  

The varied fortunes of the portfolio and investor sentiment toward the strategy as a consequence also illustrate the reality that everything is a question of timing. As they say, figures don’t lie, but liars can figure. It is no exaggeration to state that one could choose to paint any picture they want by pulling out a certain period of time and seeking to extrapolate it, from a ‘half-full’ or a ‘half-empty’ perspective.  

So, what do we think is the right period to judge performance? We have been consistent in communicating the philosophy of our approach; a concentrated portfolio, low turnover, hopefully long duration holdings. The data on the portfolio bears this out.  

Today’s portfolio has an average holding period of three years and two months. If we were to adjust duration for forced exits due to M&A activity, it would rise by another month.  

Turnover (i.e. value of trades versus value of the portfolio) is low, with the book since inception being turned over on average once every 14 months ex M&A (and including a much higher amount during the early phase of the pandemic).  

Everyone will have their own opinion on the appropriate period over which to judge performance, and also over what timeframe one should try to make decisions around portfolio risk and opportunity. We have taken, and intend to continue to take, a long-term view on such matters.  

Our philosophy and approach did not change during 2022 and 2023 and history will ultimately determine how good the approach is. At this stage though, hopefully everyone understands clearly what we are trying to do and how we are trying to do it. 

“Back to the future” 

Doubtless our readers’ email inboxes are similarly deluged to ours with prophetic pieces that portend the year ahead, usually with an optimistic skew. We have tried to write a few of these ourselves over the years and, if experience teaches us anything, it is that such pieces are seldom as useful or accurate as we wish them to be.  

As Macmillan wryly observed, events have a horrible habit of getting in the way of the best laid plans (if you want an empirical test, save the otherwise excellent Economist’s “Year ahead 2024” edition until around November and then have a re-read: prophesying is a mugs game, and no mistake).  

With the above caveats being made, there are a few observations that feel like safe ground for consulting the entrails. 2024 will see almost half the planet’s population in over 60 countries casting a vote. Some we can ignore (Russia) and some are clearly more important than others in terms of their potential geopolitical and economic implications (Taiwan, United States).  

The key question for many of our investors is whether or not 2024 being a US election year is reason enough on its own to avoid the healthcare sector for a bit longer yet, given the “truism” that healthcare underperforms during US election years. As we have noted before, this “truism” isn’t really borne out by the data. Healthcare, at an index level, does tend to lag the wider market a little in the early part of an election year (notably in Q2), and then tends to perform well on a relative basis into the election itself and the months that follow.  

The logical explanation for this is as simple as it is compelling. In the primaries, you need to appeal to the undecided voters to win the nomination, and then you need to appeal to swing voters to win overall. Healthcare-bashing is safe ground with most of the electorate so gets a lot of airtime, but it is rarely the critical issue of the day and the focus of the campaign tends to move to the most important issues as it gathers momentum.  

The 2024 election has some unusual features. Firstly, barring the imposition of an arcane sedition clause or the intervention of the grim reaper, we know that Trump and Biden will be the contestants and so the primary season is a damp squib. As a consequence, we know the policy plans too. Biden promises more of the same and Trump is offering an even Trumpier version of his first term.  

If you have a look at Trump’s “Agenda47” website, healthcare gets nary a mention. It’s all foreign policy, tax and spending and populist social issues. A tangential worry for healthcare investors is a right wing administration taking the axe to social spending including Medicare, which would of course be bad for healthcare access and, inter alia, procedure volumes.

On this note, investors can feel somewhat reassured. Trump has said the following: “under no circumstances should Republicans vote to cut a single penny from Medicare or Social Security… Republicans shouldn’t punish seniors to fund Biden’s spending spree”. Instead, the savings in the Federal budget are apparently going to come from ending “climate extremism”.  

The other topic that we are frequently asked about at the moment is M&A. It is another truism that M&A is an important element of potential returns for healthcare investors. Given the generally high levels of M&A in the sector and the need for many larger companies to buy in growth, this is an understandable point of view. There is also a perception that M&A “went away” in 2022 and 2023.  

We do not really agree with this latter observation. 2022 was a quiet year on the M&A front, especially in that typically most active area of Diversified Therapeutics companies buying pipelines. However, 2023 saw a material recovery in transaction volumes, especially in H2. This may have been less obvious to many non-specialist investors as the average ticket size was lower (many more deals in the $1-10bn range) and many of the targets were private companies, so less visible.  

When we think about the year ahead, having more confidence on the likely cost of debt financing (i.e. assurance one can re-finance at rates that are not worse than when the deal was planned) will certainly help support the appetite for bigger deals in the coming year. The need to buy in growth only ever gets bigger for large pharma and the Tools sector seeing earnings troughing out should also create some appetite for acquiring tuck ins before valuations recover.  

We always appreciate the opportunity to interact with our investors directly and you can submit questions regarding the Trust at any time via:  

As ever, we will endeavour to respond in a timely fashion and we thank you for your continued support during these volatile months.  

Paul Major and Brett Darke